Companies that have yet to switch over from the London interbank offered rate before a June phaseout deadline may have ways to hang on to the borrowing benchmark—at least temporarily.
Libor, which underpins financial contracts such as corporate loans, mortgages and interest-rate derivatives, is set to phase out on June 30 in response to a yearslong manipulation scandal. While some businesses have already transitioned to a version of the Secured Overnight Financing Rate, U.S. regulators’ preferred alternative to Libor, many other firms haven’t, particularly in the leveraged-loan market.
Regulators have urged companies and other market participants to link their loans to SOFR well in advance of Libor’s end to ensure a smooth changeover. Companies that lack transitional language in their financial contracts or haven’t manually switched to a replacement rate could face operational risk and higher costs, as their contracts could revert to the prime lending rate, a pricier benchmark, come July.
However, some of them might choose to wait even longer, either by rolling over existing Libor-linked loans for as long as 12 months just before the phaseout or potentially by using a so-called synthetic Libor now under consideration by U.K. regulators. Companies could still be dealing with the costs associated with switching to SOFR or giving priority to other financial issues over the transition, advisers said.
“For some companies, the approach may be able to give them a little bit more runway to transition if they’re coming up against the deadline and they haven’t been able to figure out the best path,” said
partner in law firm White & Case LLP’s debt finance practice, referring to rollovers.
A wave of firms—including many with leveraged loans—are expected to convert their debt agreements to SOFR over the next few months. About 78%, or $1.09 trillion, of U.S. leveraged-loan deals based on dollar volume remained tied to Libor as of Jan. 24, according to
About 9% of outstanding U.S. leveraged loans tied to Libor have no successor listed as of Jan. 20, down from 11.6% a year earlier, according to Covenant Review, a unit of research firm Fitch Solutions Inc.
Roughly 56% of the loans allow for a transition via amendments, most of which require lenders to approve or not object, Covenant Review said. Firms have been clashing with their debtholders over the amount of interest they will be paying as they switch these agreements.
The remaining 35% are set up to automatically switch to SOFR after the phaseout, with fallback language from the Alternative Reference Rates Committee, or ARRC, a group of financial firms handling the U.S. phaseout of Libor alongside the Federal Reserve Bank of New York.
Before Libor’s end, however, companies might be able to lock in a final Libor contract at the prevailing rate to carry them further, based on the terms of their loan contracts. Companies typically can elect one-, three- or six-month Libor and, in some cases, 12 months if their lenders agree.
While on that contract, firms won’t be able to refinance or increase the size of a loan or use an existing revolving credit facility without converting to SOFR. The option applies not only to companies with no changeover arrangements but also to those whose replacement terms are written into their existing-loan documents.
The rollover likely will be more expensive than switching to SOFR on time, potentially by up to 10 basis points, or 0.1 percentage point, said
co-founder of Riverside Risk Advisors LLC, an advisory firm. “Five basis points, especially for large issuers, could be a lot of money,” Ms. Frost said, adding that could represent an additional cost of $1.5 million on a $1 billion, three-year loan.
Meanwhile, the U.K. Financial Conduct Authority, the regulator in charge of overseeing Libor, is considering requiring the rate’s publisher, the ICE Benchmark Administration, to issue a synthetic version of U.S. Libor that companies could use for 15 months, through Sept. 30, 2024. Synthetic Libor rates aren’t intended to be representative of the underlying lending markets.
The financial watchdog has said it is reviewing public feedback and expects to decide later this quarter or early next quarter. The potential approval would follow previous moves by the FCA, which in 2021 permitted the temporary use of synthetic forms of Libor for certain outstanding Japanese yen and U.K. sterling contracts. The FCA declined to comment further.
Synthetic Libor, if published, could help some companies with no Libor-replacement provisions in their outstanding loan contracts to avoid needing to use the prime lending rate, which is more expensive than Libor or SOFR, said
executive vice president of research and public policy at the Loan Syndications & Trading Association Inc., a financial-services trade group. The U.S. prime rate was 7.5% as of Jan. 24, compared with Libor and SOFR, which were both at 4.3%.
Regardless of companies’ efforts to continue using Libor, the benchmark will ultimately be succeeded by SOFR, which has experienced a “tremendous take-up,” said
chairman of the ARRC and vice chairman of institutional securities at
He declined to comment on individual financial contracts.
In December, roughly $3.14 trillion globally of futures and options contracts tied to SOFR traded each day, up from $399.17 billion in the same month a year ago, according to exchange operator
CME Group Inc.
In contrast, about $877.35 billion in Libor-based derivatives were traded a day in December, down from $2.91 trillion a year earlier.
“The contractual terms are the contractual terms, whatever they may be,” Mr. Wipf said, referring to companies using “the last Libor.”
Efforts to extend the transition from Libor aren’t likely to be widely popular among companies, advisers said, in part because they are often costlier than the alternative and out of step with the market.
“A lot of our clients would rather be in line with the market than be an outlier,” said
head of the corporate hedging advisory team at financial-risk adviser Chatham Financial Corp.
“Whatever costs there are of switching to SOFR, delaying in that fashion isn’t going to change that,” Mr. Jones said. “Maybe it buys you time to sort out how to deal with those costs.”
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